Rydex Ratios Go Bonkers, Bears Are Dying Off

For many years we have heard that the poor polar bears were in danger of dying out due to global warming. A fake photograph of one of the magnificent creatures drifting aimlessly in the ocean on a break-away ice floe was reproduced thousands of times all over the internet. In the meantime it has turned out that polar bears are doing so well, they are considered a quite dangerous plague in some regions in Alaska. Alas, there is one species of bear that really is in danger of going extinct – only this one lives on Wall Street, or let us rather say, it vegetates on Wall Street these days.

Similar levels of complacency as were evident in the AAII data were reflected in Rydex ratios, which streaked to fresh extremes in recent weeks. The bull/bear asset ratio reached an astonishing new all time high of nearly 36 at one point (i.e., bullish assets were 36 times larger than bearish assets), with bear assets crumbling to a new record low.

The leveraged Rydex ratio streaked to a new all time high of 18.70 right at the turn of the year (note: from 2001 to 2012 a leveraged ratio above 2 was actually considered “extreme”).

The pure Rydex bull/bear ratio and total Rydex bear assets. We have left our annotations unchanged since the last time we showed this chart, since we have nothing new to add to this. What is new is only that the ratio actually surged to 36 – which was more than double the level it hit at the peak of the tech mania in February/March 2000. That is quite incredible.

The new record high in the leveraged Rydex ratio was set on December 29. Since then its volatility has increased quite a bit. A bout of what traders must have thought of as timely profit-taking at the beginning of the year was quickly replaced by regret and an immediate rush back into leveraged long funds – at higher prices.

Spicing it up with leverage: the ratio between leveraged bull and bear Rydex assets streaked to a new all time high at the end of the year, followed by a volatile sequence comprising a sharp decline and an immediate bounce-back. The low that was put in on occasion of this brief profit-taking interlude was at a level 3 times higher than the level considered “extremely high” in the time period 2001 – 2012.

Ursus Dejectus

Does the much larger ETF universe confirm what we see in the Rydex funds and reflect a similar extent of despondency among short sellers? It certainly appears as though stock market bears have given up on a broad front. Short positions in major ETFs have crumbled as well – SPY is particularly noteworthy in this context, as there are almost no shorts left in it at all. By contrast, in 2008 more than 30% of the ETF’s outstanding shares were sold short at one point.

Bears on the run – recently SPY shorts as a percentage of outstanding shares briefly fell to precisely zero. Once again, this situation cannot possibly get more extreme. There really is a zero bound in this case.

A long term chart of Rydex bear assets shows how extensive the wipe-out of bearish positions actually was. From their peak in early 2003, they have declined more than 95%. Even at the previous cycle low in bear assets, which was put in a few months after the peak of the tech mania in 2000, bear assets were more than 3 times higher than at the recent low (this is a bit hard to see on a linear chart, but at the time they actually stood at $317 million vs. $103 million today). Obviously, we regard the only slightly higher interim low of 2015 as part of the current market cycle.

Rydex bear assets over the long term: down 95.5% from the peak made 15 years ago and down ~66% from the previous major cycle low in late 2000.

Conclusion

We realize of course that many other technical indicators are not providing major warning signals just yet. Moreover, many sentiment and positioning data have moved from extreme to extreme for quite some time and have proved to be rather poor predictors of the market’s trend – in fact, recently they were not even much use in forecasting short term corrections (as there were none since early 2016).

Having said that, over the past several weeks most of these data have reached such outstanding readings that we would at the very least expect to see a shake-out of some sort fairly soon, even if the market’s ultimate peak is yet to come. Note that the volatility index VIX, which measures the volatility premiums of front-month SPX options, is no longer declining. After dipping below the level of 9 a few times, it has actually turned up and increased in recent days in the face of a continuing rally. This may well represent a short term warning sign.

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6 Responses to “Punch-Drunk Investors & Extinct Bears, Part 2”

Not to be overly dramatic, but I wonder if this might be the early stage of an infamous Mises “crack up boom” I’ve read about…this enthusiasm coupled with possible Treasury dumping by China would seem to set the stage. (Japan is selling too…)

Hence the analogy of Venezuela. PT rightly fingered it as a Petri Dish Katastrophenhausse. Are we about to move to the international epidemic stage? It’s been written about so much here – it would be ironic if this blog and its readers were the last to diagnose the reality of it.

Like you, Hussman and others I have watched this blow-off with horror and amazement, believing it defies both logic and history, except for the precedents of previous manias which have ended in grief.

However there is one scenario in which such market behaviour does not appear irrational or lunatic – I wonder, PT, whether you would be good enough to turn your mind to the question in a future post. There is one likely explanation for what is happening, namely that we have crossed beyond the threshold at which the only possible resolution to the debtberg is ultimate hyperinflation.

We all know that what can’t be paid back won’t be paid back, and the quantum of such malinvestment has grown even since the last crunch. After all, central banks have indeed gone “full Krugman” and credibly sworn to inflate until Doomsday. Which is more likely, that they should honour that promise or that Andrew Mellon will rise from the grave? Is what is happening here that the markets have stared into the Fed’s eyes and seen its abject weakness and moral bankruptcy? Because if so we can accept the markets’ judgement – that even this blow-off top will look like a good entry point if the S&P follows the trajectory of the Caracas stock exchange. Is the repudiation of the fiat scrip not now under way? Are not Bitcoin, Bernie Sanders, Jeremy Corbyn et al. the harbingers of the process in their different ways?

So please, PT, explain to us remaining, shell-shocked bears why we should discount a hyper-inflationary outcome when it may appear to many as the path of least resistance. Why should we believe the Bond Market Vigilantes will have a bigger popgun than the Keynesian (or worse – Marxist) cranks in charge of the printing presses? Have we simply already gone beyond the point of no return?

Related to these points, I’m curious as to how much of this run-up is due to risk-taking by large state employee pension funds. With their dire shape due in part to the demographics that put them in such a condition, it seems they are looking at taking more risk than they have in the past. I recall that it was institutions like CalPERs and CalSTERS that pressured Fannie and Freddie to take added risk in order to make the pensions’ “safe” investments look like they were getting better yield. Are the funds just now deciding to take the added risk directly themselves instead of pressuring others to do it?

We probably can’t fight the Fed. But as we seemingly embrace state(s) control of ostensibly private industry and commerce – are we even able to fight these ever-expanding state investment institutions?

@Treepower
I’ve often asked myself the same question and I too would be curious to gauge the thoughts of PT and others. If I’m not mistaken, David Einhorn, pondered this in a presentation he gave at some or other conference about a year ago, which struck a cord with me because, here was a highly successful hedge fund manager wondering if indeed he had read this all wrong and (in conclusion) he was definitely uncertain …

The thing I always come back to is that gold has not confirmed the high/hyper inflation theory (yet). Mind you, I have little doubt that it will in the years to come. A currency crisis is only a matter of ‘when’ not ‘if’. I’d imagine the next major market crisis will likely be the last before a wholesale shake-up of the monetary system, but let’s see.

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